Definition of the Multiplier Effect
- This occurs when an initial injection into the economy causes a bigger final increase in national income.
For example, if the govt increased spending by £1 billion, there would be an initial increase in AD of £1bn. However, if this eventually caused Real GDP to increase by £2 billion, then the Mulitplier would have a value of 2
Multilplier (k) = Change in Real GDP (Y)
Change in Injections (J)
Example of a Multiplier Effect.
- If the govt spent an extra £2 billion on the NHS this would cause salaries to increase by £2 billion, therefore National Income will increase by £2 billion
- However with this extra income, workers will spend, at least part of it in other areas of the economy.
- e.g. if they spent 50% of the extra income there would be another £1 billion injected into the economy. e.g. shopkeepers would earn money from increased sales.
- This extra spending would cause an increase in output, therefore firms would employ more workers and pay higher salaries.
- Therefore these workers will also increase their spending. This will lead to another injection into the economy, causing higher Real GDP
The value of the Multiplier depends upon:
- If people spend a high % of any extra income, then there will be a big multiplier effect.
- However if any extra money is withdrawn from the circular flow the multiplier effect will be very small.
k = 1 = 1
- Marginal Propensity to Consume (mpc). This is a persons willingness to spend money, if a worker saved all his money there wouldn’t be an increase in GDP
- Marginal Propensity to Withdraw (mpw). This is when money is withdrawn from the circular flow it includes mpt + mpm + mps
- The Marginal Propensity to Tax (mpt)
- The Marginal propensity to Import (mpm)
- The Marginal Propensity to Save (mps)
The multiplier will also be effected by the amount of spare capacity if the economy is close to full capacity an increase in injections will only cause inflation.
Keynesian Economics Essay
663 Words3 Pages
The U.S. never fully recovered from the Great Depression until the government employed the use of Keynes Economics. John Maynard Keynes was a British economist whose ideas and theories have greatly influenced the practice of modern economics as well as the economic policies of governments worldwide. He believed that in times when the economy slowed down or encountered declines, people would not spend as much money and therefore the economy would steadily decline until a depression occurred. He proposed that if the government injected money into the economy, it would help stimulate consumers to purchase more and firms would produce more as a result, in a continuous cycle. This cycle is called the multiplier effect. Keynes ideas have…show more content…
“The aggregate expenditures line is the summation of consumption expenditures, investment expenditures, government purchases, and net exports. The 45-degree line represents all combinations in which aggregate expenditures equal aggregate output. Keynesian equilibrium is also represented by the saving investment, or injection-leakage, model as the intersection between the injection line (investment expenditures, government purchases, and exports) and the leakage line (saving, taxes, and imports).”(2)
Keynes established the theory of the multiplier effect. Keynesians believe that, because prices are somewhat predictable, variations in spending, such as consumption, investment, or government expenditures, cause output to fluctuate. For example, if government spending increases and all other components remain constant, then output will increase. The multiplier effect is defined as “output increases by a multiple of the original change in spending that caused it.”(3) This means, that if the government were to increase their spending by ten billion dollars, it could cause the total output to rise by fifteen billion dollars (a multiplier of 1.5) or by five billion (a multiplier of 0.5). Thus the money that gets injected into the economy creates a multiplier effect and promotes more circulation of money by creating